‘Berlusconi not resigning — Italian markets fall’. That was the distillation of Monday’s headlines, and should tell the Italian prime minister all he needs to know about how to guide the country out of its gathering crisis.
On Tuesday, rebels in Berlusconi’s party have asked him to step down. Perhaps that’s why Milan stocks are up 2.48%.
Italy is circling the rim of a whirlpool. The higher its bond yields get, the faster they will rise — until the self-fulfilling prophecies come true and Italy cannot finance itself.
Markets are not treating Italy this way in isolation. They are reacting to circumstances. Two actors can change those circumstances: the EU and Italy itself.
The European Central Bank is not a third option. The ECB’s purchases of Italian bonds pushed yields down from August 5 to August 17. Since then, they have been climbing, and since November began, they have been higher than before the ECB started buying.
No one knows precisely how deep the ECB’s pockets are, but everyone knows they are limited. Therefore the ECB is not a buffer to market fears — and cannot be, unless it makes a firm and open-ended commitment to buy Italy’s debt indefinitely.
Some commentators have called for that, but the ECB has no mandate to bail out governments. Its job is to husband the single currency, and Europe would be wise to let it preserve its credibility. Those who complain that the EU is “undemocratic” — although all its decisions are taken by a council of elected national governments — would really flip if states were bailed out by an unelected central bank.
Allies without loyalty
The EU states themselves have the power to end this crisis. Unfortunately, they lack the will.
By offering their collective guarantee to the short term debts of struggling nations, in return for stringently monitored reforms, the EU nations could ensure any country had access to the public markets, without having to shell out a penny. No need for eurobonds or fiscal union. The mere existence of the programme should mean Italy and Spain would never need to use it. Yet although states guaranteed banks’ debts in 2009, they appear unwilling to do the same for their closest allies.
With Germany, France, the UK and the rest determined to dither while Rome burns, Italy must take its fate into its own hands.
As Berlusconi himself explained in his letter to the EU on October 26, Italy’s fundamentals are not dire.
In 2010, the budget deficit was 4.6% of GDP, barely worse than Germany’s 4.3% and much better than France’s 7.1%, the UK’s 7.4%, Portugal’s 9.8% or Greece’s 10.6%. This year, the government expects to run a primary surplus (before interest costs) of 0.9% of GDP.
Why, then, is Italy in such peril?
On the wrong course
Markets have lost confidence in the country’s leadership. Rather than steering Italy sharply away from the vortex as soon as it started to suck down Greece, they have squabbled and minimised the risks, appearing not to take them as seriously as investors did.
Even in late October, Berlusconi’s Northern League coalition partners blocked a move to raise the retirement age, as part of a package of reforms.
With a vast debt pile, including €260bn due in 2012, Italy has to keep the trust of the markets. But if it can regain that, there is every reason why its yields should fall and the horizon brighten.
That is why Berlusconi must go as soon as possible, making way for a broad-based government that can send a clear message to the world: Italy is serious about deficit reduction and economic reform.
Swingeing new cuts are not needed immediately. It is the direction of travel and credibility that matter.
After deficit-cutting measures introduced in the summer, the government believes it can achieve a balanced budget by 2013, a year earlier than requested by Europe. That can still happen, if markets believe in the leadership’s determination and yields fall back to affordable levels.
Yes, economic growth has been dispiritingly low for at least a decade. But the Italian economy is not dead. It shrank by a total of 6.2% in 2008 and 2009, and grew by 1.5% in 2010. Italians have €3.6tr of financial assets, dwarfing the national debt.
Italy needs far-reaching economic reform to reduce bureaucracy, streamline the legal system and breathe new dynamism into the corporate sector and labour markets. But no one should expect that this can be achieved politically overnight. Even if it were, faster growth would take at least a year or two to materialise.
New governments in Ireland, Portugal and perhaps now Greece have given reform a fresh political mandate. Italy needs the same. With the right leaders, this is not a country that should ever need a bailout.